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The ties we don't see but can't ignore

By Nick Malkoutzis

President Karolos Papoulias was correct to stress to party leaders the unusually large amount of savings being withdrawn from Greek banks over the past few days but this also caused some unnecessary arm-flapping, a practice which always obscures people?s view of what is important.

Papoulias told party leaders on Monday that 700 million euros had been withdrawn from Greek banks on Monday. Banking sources told the Financial Times that about 5 billion euros had been withdrawn since the end of April. Savings disappearing from Greek banks is nothing new. Deposits have fallen from about 240 billion euros in 2009 to some 170 billion now. However, the rate at which money is being withdrawn at the moment is a cause for concern.

The crisis has seen about 3 billion euros per month being withdrawn from banks by Greeks -- both those who are drawing on their savings to pay bills and cover other costs as well as those sending money abroad for safety. This peaked in January, when about 5 billion was withdrawn, largely due to Greeks having several tax bills to pay at the time. So, a reported 5 billion euros being taken out in just two weeks certainly should command attention.

It should do so because the Greek banking system is the country?s Achilles heel at the moment and while the focus is on whether Greece will get its next loan installment from the European Union and the International Monetary Fund so it can pay wages and pensions, the real danger could lurk elsewhere.

Greek banks are precariously balanced between collapse and at least temporary stability as they wait for the 48-billion-euro recapitalization program to be carried out. The European Central Bank said on Wednesday that this process would begin ?soon? after the settling of a dispute between the ECB and the European Financial Stability Facility (EFSF) over exactly how it would be carried out.

While the recapitalization underlines just how reliant the Greek banking system is on outside assistance, the truth is that the banks have been hooked up to the life support system for some time. Understanding this process might drive home just what a precarious position Greece finds itself in.

To make up for the loss of deposits over the last two years, the ECB has allowed Greek banks, shut out from intermarket borrowing and lacking collateral that the central bank would accept, to be financed through emergency liquidity assistance (ELA). This means that the banks are able to borrow from the Bank of Greece, rather than the ECB, by putting up collateral that is theoretically more risky than bonds, such as small business loans or mortgages. It is thought that Greek banks have borrowed about 60 billion euros this way. But the supply of money is finite. Parliament has set the limit for the ELA scheme at 90 billion euros and Greek banks do not have limitless collateral.

Furthermore, there is the possibility that the ELA tap could be turned off if central bankers in Frankfurt become concerned about Greek banks becoming insolvent. In order to access ELA, currently the banks? only source of funding, albeit a dwindling on, the ECB board needs to give its approval. But ELA funding could be halted with a two-thirds majority decision. This would cut off Greek banks from liquidity and Greece would be forced to begin printing its own money. Since it can?t print euros, the only option would be to return to the drachma.

This explains how finely balanced the situation is and why a bank run could trigger Greece?s exit from the eurozone rather than a squabble about austerity measures and loan tranches. It is extremely worrying, therefore, when some politicians in Greece keep insisting that there is no way for the country to be forced from the euro area as such a process is not included in any treaty. A halt to liquidity would end Greece?s euro membership, treaty or no treaty.

However, there is also reason to believe that the weakness of the Greek banking sector may also be a reason to keep Greece in the euro.

Deposits within the eurozone are transferred through a central payment system, known as Target2. When a depositor in Greece moves their funds to a bank in another eurozone country, the payment is processed through Target2. This creates a claim between the Bank of Greece and the rest of the Eurosystem. If there was panic in Greece about the country leaving the euro, depositors might move large amounts of funds to safer countries. These transfers would be funded by the Bank of Greece through ELA. A Greek collapse would, therefore, have a serious effect on the Eurosystem, and potentially banks in other countries.

The Bank of Greece?s liabilities to other eurozone central banks are currently thought to total about 100 billion euros. ?This is a pretty big hole to punch in the balance sheet and to divide among countries according to the ECB?s capital key,? wrote the Financial Times? Joseph Cotterill in the Alphaville blog on Wednesday. ?We suppose allowing a steep ELA increase would punch an even bigger hole but this is already a huge price for driving Greece out of the euro.?

However, the bigger issue is that uncertainty about Greece?s future in the euro could spread to Spain and Italy, which have huge liabilities. ?What policymakers and market players are worried about right now is if foreign investors see a Greek deposit crisis as a signal to rush for the exits in Italy and Spain,? wrote the BBC?s Paul Mason on Wednesday.

It emphasizes what has been increasingly evident as the Greek crisis has deepened: Despite seeming to move further apart over the last couple of years, Greece and the eurozone are bound to each other in ways that are not immediately visible. Because we don?t see those bonds, doesn?t mean that they can?t be broken. Because we don?t want to notice them, doesn?t mean that the pain will be any less if the ties are cut.